Acquisition spree brings value investing back into fashion

Your Investments: While unemployment in the US hovers around 10 percent, one would think that the state of corporate America is weak.

By AARON KATSMAN
With both a growing number of corporations sitting on piles and piles of cash and a feeling that many companies are undervalued, the mergers and acquisitions (M&A) market has started to heat up.
While unemployment in the US hovers around 10 percent, one would think that the state of corporate America is weak. Actually, nothing could be further from the truth. Corporations are very profitable but have shown an unwillingness to reinvest profits directly into their businesses by hiring workers.
Due to uncertainty over tax policy, a steady stream of new regulations and the implementation of the Obama healthcare bill, companies have hunkered down to wait out this storm until they can get more clarity about the cost of doing business. As such, they have been hoarding cash. Some recent developments now indicate that companies are starting to put their cash to work, but have decided to use their money to purchase other companies and grow through acquisition, instead of hiring workers in order to grow organically.
Robert Kapito, President of BlackRock, basically proved this thesis last week when he said:“Companies today have more cash on their balance sheets than ever before.
They’re looking to invest their cash and M&A would be the obvious choice.”
The question for investors is how to try and profit off this renewed wave of M&A?
BARGAIN HUNTING
“From 2003 through 2007, an active cycle for M&A and private equity, the S&P 500 Value index outperformed the growth index by 30 percentage points,” according to a recent article in the Barron’s magazine. For an investor, this correlation between M&A activity and value investing is certainly something to investigate and potentially even profit form, but what does it really mean? Value investing can be broadly defined as buying securities that appear underpriced based on some form of fundamental analysis.
The most famous of all value investors is Warren Buffett. He believes that you should invest in outstanding companies with sensible prices.
Take for example last week’s deal by the drug giant Pfizer. Pfizer, like other large pharmaceuticals, has been a victim of the rise in generic drugs, from the likes of Teva.
They have a huge problem replacing lost revenue from drugs that go ‘off-patent’.
“In the latest sign of corporate bargain hunting, drug giant Pfizer last week agreed to acquire Bristol, Tenn.-based King Pharmaceuticals for $3.6 billion in cash-a deal that values King at just two times trailing revenues, which despite the 40% deal premium, is even lower than Pfizer’s 2.7 times.
Acquirers like Pfizer are taking advantage of such prices to boost revenues in the face of a flagging economy and other problems.
Pfizer, for example, will see its blockbuster anticholesterol drug, Lipitor, go off patent in 2011,” according to the Dow Jones Investment Banker newsletter.
HOW TO INVEST?
It seems that early investors have already boarded the ‘value train’. According to figures from EPFR Global, a research firm that tracks investor money flows into funds, “flows into value-based exchange-traded funds are strongly positive this year while growth ETFs have experienced outflows.”
So how can investors gain exposure to value stocks?
• Invest directly in value stocks
Investors can sit down and do the research needed to make sensible investments in undervalued companies and/or industries that have been beaten up over the last few years. There are plenty of tools online that you can use to help you with search criteria and help you make decisions.
• Exchange traded funds (ETFs) and mutual funds
There are plenty of ETFs and mutual funds whose specific mandate is to solely invest in value stocks or indices which track value stocks.
There appears to be evidence of a correlation between increased M&A activity and the relative outperformance of value investing.
Still, it’s important to note that past results are no indication of future returns.
Before trying to become the next Warren Buffett, it’s important to do the necessary research that will help you discover undervalued companies. If this task seems impossible for you to do by yourself, but you would still like to make investments using this strategy, speak with a financial professional who can help you find the investments that make sense as part of your portfolio.
aaron@lighthousecapital.co.il.

Aaron Katsman is a licensed financial adviser in Israel and the United States and Israel, and helps people who open investment accounts in the US.